Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2003 Article IV consultation with the Republic of Slovenia is also available.

On April 16, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Slovenia.1

Background

Slovenia's road to European Union (EU) accession, scheduled for May 2004, has been marked by sustained real convergence in per capita income to around 70 percent of the EU average, but progress in nominal convergence has stalled, with inflation remaining stuck at about 8 percent since 1997. Against a backdrop of prudent macroeconomic policies and a gradualist approach to structural reform, Slovenia experienced strong growth in the 1990s. A high domestic saving ratio and a sound fiscal position helped keep external imbalances at bay. Slovenia attracted little foreign direct investment until 2000. However, this did not impede the manufacturing sector from restructuring, raising productivity, and maintaining its export orientation. The pace of structural reform accelerated toward the end of the 1990s. Since then, capital account transactions have been fully liberalized and significant strides have been made in fiscal and financial sector reforms, though important challenges remain.

Economic growth slowed during 2001-02 to around 3 percent, owing to a weak external environment and subdued domestic demand. Export growth slowed as demand from the EU weakened, but the impact was cushioned by a rapid expansion of exports to southeastern Europe and Russia. With imports growing more slowly than exports and the terms of trade improving, the external current account swung into surplus in 2001 and strengthened further in 2002, reflecting a satisfactory competitive position.

Progress with disinflation continued to be slower than envisaged, in part owing to unanticipated large increases in indirect taxes, oil prices, and non-oil administered prices. Wage pressures lessened in 2002, and real wage increases receded below productivity growth.

Monetary conditions varied during 2001-02. The real interest rate on 60-day tolar bills exhibited sharp swings, including turning negative for a brief period in the later part of 2001. The exchange rate of the tolar vis-à-vis the euro depreciated continuously at varying rates, around a decelerating trend path. Foreign direct investment increased sharply to the equivalent of about 9 percent of GDP in 2002. The privatization receipts of the government were deposited in the Bank of Slovenia (BoS), and the rest of the inflows were largely sterilized through open market operations. Thus, base money growth in 2002 was limited to 8.6 percent. Domestic credit growth to the private sector and corporate borrowing abroad slowed significantly, reflecting weak demand.

The general government deficit has remained slightly below 1.5 percent of GDP since 2000.2 In contrast to 2001 when there were expenditure overruns, the budget came under pressure in 2002 because of revenue shortfalls arising from weaker-than-expected domestic demand. The government responded through a combination of expenditure cuts and upward revision of the fiscal deficit target.

Some key structural measures were implemented in 2002, but a backlog developed on the privatization front. As of July, financial contracts with maturity of less than one year ceased to be indexed to inflation. Thirty-nine percent of the shares of Nova Ljubljanska Banka (NLB), Slovenia's largest bank, were sold to foreign investors. However, the privatization of Nova Kreditna Banka Maribor and Telecom was postponed.

Growth is expected to pick up only slightly in 2003, in the face of uncertainties about the strength of the EU's expected recovery and the drag from higher international oil prices. For 2004, real GDP growth is projected to climb to 3.8 percent on the basis of a continued recovery in Europe and a strong pickup in private consumption. The current account would likely remain in surplus of about 1.8-2 percent of GDP in 2003-04. The two-year rolling budget is subject to risks and the deficit targets (1.2 percent of GDP in 2003 and 0.9 percent in 2004) are unlikely to be achieved under present policies. The BoS has announced inflation forecasts of 5.3 percent for end-2003 and 3.5 percent for end-2004; staff projection for end-2004 suggests an outcome of around 4.8 percent unless policies are tightened further.

Executive Board Assessment

Executive Directors commended the authorities for their prudent macroeconomic management, noting that Slovenia had achieved sustained real convergence toward EU levels during the 1990s and already met the Maastricht fiscal criteria. Full fiscal consolidation is broadly on track, foreign exchange reserves are at a comfortable level, foreign investment inflows remain strong, and productivity growth has supported export competitiveness. Directors observed that in 2001-02, Slovene exports had gained market shares in non-EU countries, which had helped offset weaker demand from the EU.

Directors considered that, with EU accession scheduled for May 2004, and taking into account the limited progress made on the disinflation front since 1997, the main policy challenge now is to lower inflation and inflation expectations, while entering ERM2 at a viable exchange rate. The widespread indexation in economic transactions, especially wages, pensions, and financial contracts, is an important factor behind the stickiness of inflation, and Directors encouraged the authorities and social partners to eliminate indexation mechanisms to speed up disinflation.

Directors stressed that sustained efforts by monetary policy would also be needed to contribute to achieving the disinflation objective. In this regard, Directors saw scope for lowering inflation by accepting a stronger tolar, without unduly exposing the economy to risks, given the strong external current account position. Directors recommended that, to increase accountability, the BoS forecast and monitor a core inflation measure that excludes administered prices, indirect taxes, and oil prices. Treating inflation goals as targets rather than projections would also help to build policy credibility and convince economic agents of the seriousness of the authorities' disinflation agenda.

Directors considered that cost-push factors, which had accounted for much of the persistence of inflation in recent years, should be tackled vigorously. They welcomed, in this regard, the enhanced coordination between the government and the BoS on plans for adjustments of administered prices. However, caps on administered price increases should not be allowed to substitute for policy tightening, or to lead to losses for service providers.

Directors endorsed the government's medium-term fiscal goal of attaining close to structural balance before adopting the euro. However, they noted that the deficit targets of the rolling two-year budget for 2003-04 might not be achieved under present policies, given the uncertainty of the revenue projections and the likely initial adverse fiscal effect of EU accession. While a somewhat higher deficit than originally envisaged might result in 2003, Directors underscored the need to return in 2004 to the previously planned pace of fiscal adjustment.

Directors considered that efforts to restrain expenditures over the medium term would have to focus at an early stage on wages and social transfers, which constitute the bulk of public spending. Lower public sector wage increases, maintaining the freeze on public sector hiring, and elimination of wage indexation are priorities for meeting the medium-term inflation and fiscal goals. Directors commended the authorities for taking measures to contain public sector wage increases to below economy-wide increases. They welcomed the recent social agreement on public and private sector wages, which links wages to the average EU inflation rate. At the same time, Directors encouraged the government and social partners to keep the cost of the new wage structure within the budgeted wage bill for 2004. Directors pointed out that further savings on pension expenditure could be achieved by indexing pensions to inflation instead of to wages. They urged the authorities to pursue with determination the planned health care reforms.

Directors noted that significant strides in structural reforms have been made in the past few years, and encouraged the authorities to maintain the momentum. Directors welcomed the initiatives underway to reduce the role of the state in the steel and energy sectors, and encourage them to accelerate privatization in general.

Directors considered the banking system to be generally sound. They welcomed the progress in the implementation of the authorities' financial sector action plan, which had strengthened the BoS's ability to cope with any evolving risks under a liberalized financial sector and external capital account. Directors stressed the importance of monitoring closely the rising foreign currency borrowing by enterprises, so that credit risks remain well contained. Directors observed that competition in the banking system has increased with the entry of foreign investors, and they encouraged the authorities to enhance the competitiveness of Nova Kreditna Banka Maribor, the second-largest bank, through an infusion of private capital.

Directors endorsed the de-indexation of short-term financial contracts in mid-2002 and the subsequent initiative taken by banks to begin offering long-term financial instruments at nominal interest rates. These measures have strengthened the interest rate transmission channel of monetary policy and improved the operation of the money market. Directors encouraged the authorities to eliminate indexation of all financial instruments at an early date.

Slovenia: Selected Economic Indicators, 1999-2004

Prelim.

Proj.

1999

2000

2001

2002

20031

20041

(Annual percentage change)

Real GDP

5.2

4.6

3.0

2.9

3.2

3.8

Domestic demand

9.1

1.1

0.5

2.2

3.1

4.0

Private consumption

6.0

0.8

1.7

1.8

2.3

3.7

Public consumption

4.6

3.1

3.2

1.0

1.5

2.1

Gross capital formation

18.9

0.5

-3.7

3.7

5.8

6.0

Industrial production

-0.5

6.2

2.9

2.4

...

...

Consumer prices

Period average

6.1

8.9

8.4

7.5

5.7

5.0

End of period

8.0

8.9

7.0

7.2

5.3

4.8

Wages

Nominal

All sectors

9.6

10.6

11.9

9.8

7.8

7.0

Manufacturing

9.1

11.9

10.8

9.9

...

...

Public services

10.1

11.2

13.9

11.6

7.8

6.5

Real

All sectors

3.3

1.6

3.2

2.1

2.0

2.5

Manufacturing

2.8

2.8

2.2

2.2

...

...

Public services

3.7

2.1

5.1

3.8

2.0

2.0

Employment

Person basis

1.8

1.3

1.4

0.6

0.4

0.7

Full-time equivalent

1.2

1.1

0.6

0.1

2/

0.2

0.4

Unemployment rate (in percent, ILO definition)

7.6

7.0

6.4

6.3

2/

6.3

6.2

General government finances

(In percent of GDP)

Revenue

43.6

42.8

43.1

40.8

3/

42.9

42.7

Expenditure

44.2

44.1

44.5

43.7

44.1

43.6

General government balance

-0.6

-1.4

-1.4

-2.9

3/

-1.2

-0.9

State budget balance

-0.5

-0.9

-1.1

-2.8

3/

-1.0

-1.0

General government debt

24.9

25.8

27.5

28.4

26.3

25.8

Money and credit

(Percentage change, end-period)

Broad money (including foreign exchange deposits)

13.2

15.3

30.4

17.3

...

...

Base money

16.4

4.8

21.4

8.6

...

...

Credit to the private sector

25.0

18.4

18.3

11.1

...

...

Interest rates (in percent)

BoS discount rate

8.0

8.7

10.8

10.0

...

...

Rate on 60-day BoS bills

7.1

8.2

10.4

8.3

...

...

Lending rates

12.4-14.2

15.8-17.7

15.1-17.1

11.9-14.7

...

...

Deposit rates 4/

7.2-8.9

10.0-12.1

9.8-12.3

7.6-8.6

...

...

Balance of payments

(In millions of U.S. dollars)

Merchandise exports

8,623

8,808

9,343

10,473

12,149

13,208

Exports volume (percent change)

2.7

12.8

6.6

6.2

6.6

7.0

Merchandise imports

-9,858

-9,947

-9,962

-10,716

-12,364

-13,471

Imports volume (percent change)

8.8

6.1

2.2

4.5

6.2

7.3

Current account balance

-698

-548

31

375

476

441

(in percent of GDP)

-3.5

-3.0

0.2

1.8

1.9

1.7

Gross official reserves

3,168

3,196

4,397

7,064

8,230

8,945

(in months of imports of goods and nonfactor services)

3.3

3.4

4.6

6.8

6.8

6.8

External debt (percent of GDP, end-period)

Total

26.9

34.3

35.7

41.5

37.9

38.4

Of which: Public and publicly guaranteed

12.2

14.7

14.4

15.3

14.0

14.2

External debt service

840

1,012

1,652

1,820

2,014

2,310

(in percent of exports of goods and nonfactor services)

8.0

9.5

14.6

14.3

13.6

14.4

Exchange rate

Tolars per U.S. dollar (end-period)

196.8

227.4

250.9

221.1

...

...

Tolars per euro (end-period)

197.3

211.5

221.4

230.3

...

...

Nominal effective exchange rate (1998Q1=100, period average)

96.8

90.6

85.0

81.8

...

...

Real effective exchange rate

CPI based (1998Q1=100, period average)

103.0

102.1

101.1

102.8

...

...

ULC based (1998Q1=100, period average)

100.7

97.2

98.1

100.1

2/

...

...

Sources: Data provided by the Slovene authorities; and IMF staff calculations and projections.

1/ IMF staff projections for real GDP and components, inflation, employment, balance of payments, and external debt. Figures for general government finances for 2003-04 refer to the budget approved by Parliament.

2/ Average of the first three quarters of 2002.

3/ Figures reflect a shift in the budget accounting to a pure cash basis entailing 11 months of VAT and excise tax revenues. Adjusted for this, revenues would be 42.3 percent of GDP and the general government deficit would be 1.4 percent of GDP.

4/ For deposits with maturity between 31 days and 1 year.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.2 Adjusting for the one-time impact of an accounting shift in 2002; otherwise, the measured deficit that year was slightly below 3 percent of GDP.